Capitalizing on the Evolving Energy Landscape

Capitalizing on the Evolving Energy Landscape SACRS Investment Breakout May 13, 2015 Andrew Brett, CAIA, Research Consultant

Table of Contents 1. Executive Summary 2. Recent Events: The Impact of Falling Oil Prices 3. Putting the Oil Supply and Demand Balance in Perspective 4. Factors That Will Impact Future Oil Prices 5. Investment Opportunity and Environment: Scenario Analysis 6. Appendix 7. Detailed Product Summaries 2

1. Executive Summary

Executive Summary Oil has rallied in recent weeks and is trading in the high $50 s (WTI), significantly higher than the trough price reached in Q1 (~$43) but well below the one-year high of $107 reached in June 2014 Manager expectations are that oil will remain volatile throughout 2015 and most of 2016 (potentially falling well below current price) as supply/demand forces work to balance but that near the end of 2016, oil should reach an equilibrium price of $70-$75 NEPC shares this viewpoint Under this scenario, consensus is that public E&P/services companies and private asset owners will experience meaningful distress with winners and losers Most companies should be okay for the majority of 2015, however as oil remains low longer and hedges roll off, revolvers get resized, cash flows start to decrease and debt maturities get closer, the pain will increase and companies will be forced to adjust Given this as a baseline, NEPC s view of the investment opportunity are as follows: In the near-term, long-biased equity strategies, long/short equity strategies and stressed/dislocated credit strategies should be attractive Long/short commodity strategies could be interesting now assuming volatility persists The long/short commodity play, using commodity derivatives, is less a bet on the path of oil but the interim volatility of oil and the manager s ability to gauge price movements As the stress starts to build in late 2015 and 2016, distressed credit, rescue financing/bridge financing/dip and private equity strategies should become attractive 4

2. Recent Events: The Impact of Falling Oil Prices

What s Happened: Historical Crude Oil Prices Crude oil prices are significantly lower than the peak price of $105 reached in June 2014, but have rebounded from their early 2015 lows The recent decline represents the second largest decline since 2000 $160 Crude Oil Prices $140 $120 $105.37 $100 $80 $60 $40 $59.63 $20 WTI Crude Oil Spot Price Brent Crude Oil Spot Price $0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: Bloomberg; data as of April 30, 2015. 6

What s Happened: Headline Factors Driving Oil Prices Lower Factors Driving Lower Oil Prices in 2014 Supply outpaced demand Ongoing increases in US oil shale production 96 Global Liquids Supply & Demand Balance 6.0 Unexpected supply rebound in Libyan production in 2H 2014 94 92 5.0 4.0 OPEC decided not to cut production Demand forecast revised down Demand grew, but slower than expected Stronger dollar negatively impacts oil prices MMBod 90 88 86 84 82 80 78 Implied Stock Change (RH) World Production (LH) World Consumption (LH) Forecast Q1 13 Q3 13 Q1 14 Q3 14 Q1 15 Q3 15 3.0 2.0 1.0 0.0 (1.0) (2.0) (3.0) MMBod $160 $140 $120 $100 $80 $60 $40 Oil Prices vs. USD 1,250 1,200 1,150 1,100 1,050 1,000 950 YOY Change (MMbod) 1.6 1.2 0.8 0.4 IEA World Demand Increase Forecast Jul Dec $20 Brent Crude Oil Spot Price $0 Bloomberg Dollar Spot Index 2007 2009 2011 2013 2015 900 850 0.0 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 Source: Bloomberg, IEA; data as of April 30, 2015. 7

The Impact of Low Oil Prices: Fixed Income Markets Upstream energy represents $114.8 billion of outstanding high yield debt $220 US Energy High Yield Yields spiked on energy high yield issuances (but higher quality credits have experienced a rebound) JPM projects default rates of energy high yield bonds of over 20% if oil stays below $65 through 2016 $200 $180 Full Market Value ($B) $160 Jun-14 Aug-14 Oct-14 Dec-14 Feb-15 Apr-15 25.0% 20.0% Expected Energy HY Default Rates Oil at $75/barrel Oil at $65/barrel 20.50% 11.0% US Energy High Yield 9.0% 15.0% 10.0% 7.0% 5.0% 3.90% 3.90% 4.80% 0.0% 2015 2016 15yr Avg = 1.34% Yield to Maturity 5.0% Jun-14 Aug-14 Oct-14 Dec-14 Feb-15 Apr-15 Source: JPM, Bloomberg; data as of April 30, 2015. 8

The Impact of Low Oil Prices: Public Markets Public equity markets have sold off from 2014 peak prices: Oil E&P companies down 18% Oilfield service companies down 33% MLPs down 9% Upstream and Oilfield Services Forward P/E Ratios have spiked as estimated EBITDA has fallen MLPs have been more resilient, as large portion of revenues are contracted or volume-based Price Index 110% 100% 90% 80% 70% 60% Upstream Oil 50% MLPs Oilfield Services 40% Jun-14 Aug-14 Oct-14 Dec-14 Feb-15 Apr-15 35.0x Forward P/E Ratios $420 Estimated Next Year EBITDA $80.0 30.0x $400 $68.0 25.0x 20.0x $380 $56.0 15.0x $360 $44.0 10.0x Upstream Oil (LA) 5.0x MLPs (RA) Oilfield Services (LA) 0.0x Jun-14 Aug-14 Oct-14 Dec-14 Feb-15 Apr-15 $340 Upstream Oil (LA) $32.0 MLPs (RA) Oilfield Services (RA) $320 $20.0 Jun-14 Aug-14 Oct-14 Dec-14 Feb-15 Apr-15 Source: Bloomberg; data as of April 30, 2015. 9

The Impact of Low Oil Prices: Sources of Liquidity 2015 budget and commodity price outlook forcing management teams to consider liquidity options Companies will seek to improve liquidity using the least dilutive options and will consider more dilutive alternatives as distress increases E&P Company Liquidity Options Bankruptcy Issue junior debt Sell assets Perceived Dilution Companies are currently evaluating these options Issue convertible preferred/preferred equity Stock for stock mergers Issue term loans JV upstream assets Monetize midstream assets Distress Level and Time Source: Apollo Management 10

3. Putting the Oil Supply and Demand Balance in Perspective

Putting the Oil Supply and Demand Balance in Perspective Short-term supply/demand fluctuations and imbalances are not uncommon Current oil demand of 92.4 million barrels of oil per day ( MMbod ) Current oversupply of 1 to 2 MMbod (~2% of current demand) 96 Global Liquids Supply & Demand Balance 6.0 94 5.0 92 4.0 90 3.0 MMBod 88 86 2.0 1.0 MMBod 84 0.0 82 (1.0) 80 78 Forecast 2009 2010 2011 2012 2013 2014 2015 2016 Implied Stock Change (RH) World Production (LH) World Consumption (LH) (2.0) (3.0) Source: EIA Short-Term Energy Outlook; data as of April 2015. 12

Putting the Oil Supply and Demand Balance in Perspective (Cont.) Increased Domestic Supply Increase in US production largest contributor to recent global supply growth Supply Expected to Peak in 2015 due to capex from last year contributing to new production; this is slowing United States is a Major Energy Producer but OPEC accounts for a large amount of estimated global proven reserves MMbod 5.0 4.0 3.0 2.0 1.0 0.0 (1.0) Change in Liquids Production Since 2010 OPEC United States Non-US, Non-OPEC (2.0) Q1 2012 Q3 2012 Q1 2013 Q3 2013 Q1 2014 Q3 2014 Q1 2015 Growing Global Demand Demand for oil has grown at 1.2% per year since 2000 Unlike prior price declines, demand has not contracted (yet) 120 100 80 76.6 Global Liquids Consumption 92.3 Rising Emerging Market Demand Non-OECD demand growth rate of 3.3% per year since 2000 OECD demand growth of -0.4% during the same period MMbod 60 40 20 Source: BP, EIA; data as of April 2015. 0 2000 2002 2004 2006 2008 2010 2012 2014E 13

4. Factors That Will Impact Future Oil Prices

Factors that Will Impact Current Low Oil Prices 1 Forward production ex-new drilling 2 Breakeven prices 3 Breakeven Capital investment prices response 4 Supply shocks from at Risk sources 5 Non-OECD demand growth 6 Market expectations 7 What keeps oil prices low 15

1 Forward Production Ex. New Drilling: Supply Falls Off Quickly Given the decline rates for many wells, without continued capital investment supply rolls off below current demand levels Aggregate Base Production Declines 120 Actual Expected 100 6 11 16 22 80 MMbod 60 40 88 88 89 90 86 82 78 74 20 0 2010A 2011A 2012A 2013A 2014E 2015E 2016E 2017E Note: Assumes 5% decline rate if no new investment. Source: WL Ross; data as of December 2014. 16

2 Breakeven Prices: Well Above Current Prices $160 $140 $120 $100 $140 OPEC Fiscal Breakeven* $121 $121 $119 $117 $106 $98 $93 $90 OPEC Break Even Prices Current Brent Price $80 $75 $70 $65 $60 $40 $20 $0 Iran Venezuela Algeria Nigeria Ecuador Iraq Angola Saudi Arabia Libya Kuwait United Arab Emirates Qatar $120 $100 $80 $60 $40 Shale Breakeven Prices Current WTI US Shale Economic Breakeven* $34 $41 $42 $43 $45 $47 $50 $51 $52 $52 $53 $56 $57 $58 $60 $61 $62 $63 $65 $67 $68 $69 $71 $72 $81 $91 $20 $0 Notes: For OPEC, fiscal breakeven represents the oil price required to meet each country s budget (including social programs). For US Shale, economic breakeven is the price needed to achieve a 10% IRR. BK=Bakken, NB=Niobrara, PM=Permian, TF=Three Forks Source: Bloomberg, Wall Street Journal, Macquarie as of December, 2014; oil prices as of April 30, 2015. 17

3 Capital Investment Response: Response Already Occurring Capex budget reduction of ~40% across the industry expected in 2015 1,800 1,600 US Crude Oil Rig Count Baker Hughes US Crude Oil Rotary Rig Count Rig count has dropped by 883 (~57%) a faster decline than initially expected 1,400 1,200 Energy credit markets are open for now: Large, existing companies with strong balance sheets still able to secure attractive financing Capital is much more expensive for weaker companies with high leverage levels exacerbated by falling EBITDAX Less capital available for smaller, high-growth companies than in past years Reserve-based lending facilities were re-priced this spring and reductions were relatively small, the next redetermination is in the fall and will be more severe if prices remain low 1,000 800 600 400 200 0 2002 2005 2008 2011 2014 Source: Bloomberg, Baker Hughes, IHS; data as of May 1, 2015. 18

4 Supply Shocks from at Risk Sources: OPEC Produces 40% of World Oil 10.0 OPEC Production & Breakeven Levels Production (LA) Fiscal Breakeven (RA) $150 8.0 $120 6.0 $90 MMbod 4.0 $60 2.0 $30 0.0 Saudi Arabia United Arab Emirates Kuwait Qatar Iraq Iran Venezuela Nigeria Angola Algeria Ecuador Libya $0 52% of OPEC production from stable sources 48% of OPEC production from at risk sources Source: EIA, Wall Street Journal; data as of December 2014. 19

5 Non-OECD Demand Growth: BRIC Consumption Non-OECD countries responsible for future demand growth 50 Oil Consumption vs. GDP China Rising middle class in countries with large population should drive longterm oil demand Oil Consumption Per Capita (barrels/person/year) 40 30 20 10 0 India United States Brazil Russia Japan Germany United Kingdom Saudi Arabia (10) ($10,000) $0 $10,000 $20,000 $30,000 $40,000 $50,000 $60,000 $70,000 GDP per Capita (Current USD) Note: Bubble size indicates each country s population. Source: World Bank; data as of December 2013 (most recent available). 20

6 Market Expectations: $100 Was Too High; $50 is Too Low Banks forecasting recovery in oil prices over next few years (except Citi) Most believe that supply and demand will come into balance at some point in 2016 and prices will increase $100 $75 $50 Bank Forecasts April 2015 Futures $25 CS Projected WTI JP Morgan Projected WTI Macquarie Projected WTI Citi Projected WTI BOAML Projected WTI $0 2015 2016 2017 2018 Futures are not a good predictor of price However, the price at which producers can hedge production has not fallen as dramatically as the spot price $120 $100 $80 $60 WTI Crude Futures Curves Futures pricing is partially driven by current spot prices, which have been volatile $40 $20 $0 Trailing 3 Month Spot Price Range April 2015 January 2015 June 2014 2015 2016 2017 2018 2019 2020 Expiration Source: Bloomberg, Credit Suisse, JP Morgan, Macquarie, Citi, BOAML; data as of April 30, 2015. 21

7 What Keeps Oil Prices Low: The Bear Factors OECD demand is flat-to-negative; does it get worse? Do current economic conditions get worse (Europe, China growth, etc.)? Continued strength of US dollar Global production stability OPEC focuses on becoming a volume producer Alternative energy sources 22

5. Investment Opportunity and Environment: Scenario Analysis

Investment Opportunity and Environment Oil has rallied in recent weeks and is trading in the high $50 s (WTI), significantly higher than the trough price reached in Q1 (~$43) but well below the one-year high of $107 reached in June 2014 Supply has continued to grow despite the rig count dropping 57% from the peak; however, there are signs that production growth is slowing more quickly than expected Demand is believed to be increasing: IEA expects demand to accelerate to 1.1 million barrels per day in 2015 and there is evidence that this is already occurring The current WTI forward curve remains in contango but less severe than in Q1 NEPC continues to have regular conversations with investment managers to refine our view of actionable products and attractive strategies This includes commodity managers, equities managers, hedge fund managers, credit managers, distressed-oriented managers and private equity managers Manager expectations are that oil will remain volatile well into 2016 and the possibility of prices retreating lower, but oil should reach an equilibrium price of $70-$75 as supply tightens NEPC shares this view Under this scenario, consensus is that public E&P/services companies and private asset owners will experience meaningful distress with winners and losers One manager estimated that over 50% of companies in the space will have to raise capital, sell assets, restructure debt, be acquired or go bankrupt in this scenario Most companies should be okay for the next six-to-nine months, however If oil remains low longer and hedges roll off, revolvers get resized, cash flows start to decrease and debt maturities get closer, the pain will increase and companies will be forced to adjust 24

Relative Attractiveness, Risk and Timing of Different Investment Strategies Determining the best investment strategy today is complex and dependent on the future price of oil and price volatility We ve thought about this question using three different scenarios: 1. Oil remains volatile for the first half of the year but rebounds to $70-75 by year-end 2. Oil remains volatile in current range but rebounds to $70-$75 in next 18-24 months 3. Oil remains volatile around the current range well past 2016/17 Most investment managers (and NEPC) believe #2 is the likely scenario Oil Price Scenarios: Relative Attractiveness, Risk and Timing Future Oil Price Expectations Return Potential $70-75 by Year-End $70-75 in the next 18-24 Months Current range well past 2016/17 Downside Risk Investment Timing Return Potential Downside Risk Investment Timing Return Potential Downside Risk Investment Timing Long-only commodities Now NA NA Long/short commodities Now Now NA Long-only equities Now Now NA Long/short equities NA Now NA Long-only MLPs Now NA NA Long/short MLPs NA NA NA Stressed / dislocated credit Now Now 2016 Distressed credit NA 2H15/16 2016/17 Private equity investments 2015 2H15/16 2016/17 Return Potential High Low Downside Risk High Low 25

Appendix

Spectrum of Investment Options What are the best investment strategies and products given the current market environment To help think through this, we ve segmented the opportunity set into the following investment options: Asset Type Long-only commodities Long/short commodities Long-only equities Investment Description Long-only positions in commodities futures with consistent exposure to contracts expiring at various delivery points Long and short positions in commodity derivatives; directional and relative value trades used to capture price movements, volatility, and geographic spreads in oil prices Long-only positions in E&P and energy services company stocks Long/short equities Long-only MLPs Long/short MLPs Stressed / dislocated credit Distressed credit Private equity investments Long and short positions in mispriced E&P and energy services company stocks Long-only positions in a portfolio of midstream-related MLPs, and sometimes in c-corps and related GP shares Long and short positions in midstream-related MLPs, c-corps, GPs, and potential PIPEs and other investments in related midstream entities Long and short positions in mispriced E&P, energy services and MLP debt (secondary purchases and new issuance), options, CDS, index hedges Direct lending, bridge financing, private placements, bankruptcy situations, workouts, DIP financing, rescue financing, loan-to-own strategies Asset acquisitions, joint ventures, recaps, take-privates 27

Qualitative Views: Scenario 2 (Oil Reaches $70-75 in the next 18-24 Months ) 2. Oil remains volatile in current range but rebounds to $70-$75 in next 18-24 months: Public E&P/services companies and private asset owners will experience meaningful distress with winners and losers One manager estimated that over 50% of companies in the space will have to raise capital, sell assets, restructure debt, be acquired or go bankrupt in this scenario Most companies should be okay for the next six-to-nine months, however: As oil remains low longer and hedges roll off, revolvers get resized, cash flows start to decrease and debt maturities get closer, the pain will increase and companies will be forced to adjust Given this as a baseline, NEPC s view is of the investment opportunity and environment are as follows: In the near-term long-biased equity strategies, long/short equity strategies and stressed/dislocated credit strategies should be attractive Long/short commodity strategies could be interesting assuming volatility persists The long/short commodity play, using commodity derivatives, is less a bet on the path of oil but the interim volatility of oil and the manager s ability to gauge price movements As the stress starts to build in late 2015 and 2016, investments in distressed credit, rescue/bridge/dip financing and private equity strategies should emerge 28

Asset Class Views: Scenario 2 (Oil Reaches $70-75 in the next 18-24 Months) Relative Attractiveness, Risk, Timing and Commentary Future Oil Price Expectations Return Potential Base Case Downside Risk Investment Timing Comments on Opportunity Long-only commodities NA Futures curve in contango creating negative roll yield in near-term; going long on the curve provides only marginally attractive returns under scenario Long/short commodities Now Alpha potential from continued volatility and not based on oil price recovery; lower volatility makes this investment less attractive Long-only equities Now Highest return potential (especially in fast oil price recovery scenario); risk of prolonged downturn (> 2 years) would impair equity values; high volatility expected in near-term Long/short equities Now Ability to generate alpha around volatility while participating in recovery (e.g. buy the winners and short the losers) Long-only MLPs NA MLPs have stable revenue in near-term however price dislocation has been smaller than equities and risks to revenue growth in long-term should upstream drilling activities decline for a significant period of time Long/short MLPs NA Ability to generate alpha around volatility while participating in recovery (e.g. buy the winners and short the losers); less upside (with lower expected volatility) than long/short equities as MLPs have less sensitivity to commodity prices Stressed / dislocated credit Now Equity-like return potential with credit downside; principal losses likely should asset values diminish due to poor covenant protections; shorts could benefit from further distress; large amounts of capital flowing to this opportunity Distressed credit 2H15/16 Traditional distress not likely until 2016 due to hedging and sufficient liquidity; new origination, private placements and direct lending to fill void in capital structure presenting opportunities Private equity investments 2H15/16 Near-term bid/ask spread remains wide, attractive acquisition opportunities likely once companies rationalize assets and M&A activity increases Return Potential High Low Downside Risk High Low 29

Qualitative Views: Scenarios 1 and 3 1. Oil remains volatile for the first half of the year but rebounds to $70-75 by year-end: Under this scenario, consensus is that public E&P/services companies and private asset owners will avoid meaningful distress and that mispriced credits and equity prices will rebound quickly once market confidence in the equilibrium price returns If oil follows this path and the market believes in the new equilibrium price of $70+, then the most attractive strategies should be the long-only strategies (E&P/Energy Services equities and MLPs) Long-only stressed/dislocated credit should also do well Long-only commodity strategies should also perform well, although the futures curve remains in contango, meaning that roll-yield remains a drag on total return 3. Oil remains volatile around the current range well past 2016/17: Under this scenario, the general consensus is that public E&P/services companies and private asset owners will experience widespread distress In this case, short biased equity and credit strategies should do the best Distressed credit, rescue financing/bridge financing/dip and private equity strategies should also become attractive but likely later in the cycle versus the case above (early entrants here might have too lofty views on the long-term price of oil and over-pay) Long-only commodity strategies would not do well until the curve flattens (or reaches backwardation) Long/short commodity strategies should have the potential to do well assuming volatility remains high From a macro perspective, this scenario would likely be driven by decreasing oil demand tied to lower global GDP growth, energy-related technology advancement or OPEC s ability to significantly increase output becoming volume-focused as opposed to price-focused 30

Alternative Investment Disclosures

Alternative Investment Disclosures It is important that investors understand the following characteristics of nontraditional investment strategies including hedge funds and private equity: 1. Performance can be volatile and investors could lose all or a substantial portion of their investment 2. Leverage and other speculative practices may increase the risk of loss 3. Past performance may be revised due to the revaluation of investments 4. These investments can be illiquid, and investors may be subject to lock-ups or lengthy redemption terms 5. A secondary market may not be available for all funds, and any sales that occur may take place at a discount to value 6. These funds are not subject to the same regulatory requirements as registered investment vehicles 7. Managers may not be required to provide periodic pricing or valuation information to investors 8. These funds may have complex tax structures and delays in distributing important tax information 9. These funds often charge high fees 10.Investment agreements often give the manager authority to trade in securities, markets or currencies that are not within the manager s realm of expertise or contemplated investment strategy